Macro Theme:

Key dates ahead:

Founder’s Note:

Futures are off 14bps after the SPX yesterday regained the 6,100 level.

Resistance: 6,127, 6,150

Support: 6,100, 6,050, 6,020, 6,000

TLDR: We think a breakout is at hand, and continue to want to express this view via slightly out-of-the-money call options. Calls are both 1) cheap and 2) offer fixed risk in the event that another headline sparks a gappy downside move.

This is now the 4th time in the last month that the SPX has tested the >=6,100 area. Each of the previous 3 times the move has failed violently, as shown below. Our general thesis is that a move >=6,100 should start to invoke some positive gamma which helps to reduce realized volatility, as dealers buy equity dips. Adding to our bullish thesis has been that a potential rally in major single stocks could provide the beta-based lift to lead to a surge in stock prices. Finally, we feel that calls are being underpriced in the SPX, as well as single stocks like MSFT & META. Should this rally continue we could see those call IV’s increase, which adds momentum via dealer hedging (buying into rallies).

Those pieces seem to have started to fall into place yesterday, but the question is: is this time different?

Starting with a vol check, we see that fixed strike vol for any expiration out bast next weeks OPEX is essentially unchanged. Take today’s1-month skew (teal) for example, which when compared to the same expiration vol on 2/11 (pre-CPI, gray) you can see that the far left tail has come down (i.e. puts), but anything near-the-money has not changed at all. If that vol can start to compress then we think the equity rally gains stability. The left tail coming down is a bullish signal, and we’d argue that those longer dated IV’s at 10-13% don’t have much room left to compress.

There was also a startling drop in COR1M, which measures S&P500 correlation. This is a sign that 1-month single stock vols are decoupling from index vol. As we know, SPX vol is quite stable, and so this COR1M index is signaling a single stock breakout as single stock vols decline. This typically happens after earnings, but in this case the larger earnings were last week, and so we take this COR1M decline as a “macro” response.

COR1M is precariously close to our “red flag” level near 8 (see “2017 level” in the chart). This leads us to the short term view that a blow-off top may be at hand, but in the medium term things are quite risky.

Our full “blow off->blow up” thesis (including COR1M primer) can be found here.